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Tax Court grants innocent spouse relief from taxes on embezzled funds

The taxpayer's subsequent knowledge of the embezzlement prevents relief for a second tax year.

The Tax Court granted innocent spouse relief from tax liabilities for one year for which evidence showed a husband was unaware of his wife's embezzlement of funds omitted from income reported on their return. The court denied relief, however, for the following year, during which the wife was convicted of the embezzlement.

Facts: The taxpayer, Rick E. Jacobsen, an employee and home inspection business owner with no formal business education, relied on his wife, Tina Lemmens, an accountant for a local blood bank, to manage the family's personal finances as well as those of his home inspection business, because of her training as an accountant. Jacobsen also received veteran's disability benefits and suffered from post-traumatic stress disorder.

In June 2011, Lemmens was arrested for embezzling approximately $485,000 from her employer over several years, including 2010 and 2011, the tax years in issue. Before her arrest, Jacobsen never reviewed the couple's bank or credit card statements. Jacobsen did not become aware of the embezzlement until Lemmens's arrest. She was convicted in November 2011 and sentenced in January 2012. The couple divorced in 2015.

For the 2010 tax year, Jacobsen gave Lemmens his tax information, and she hired a paid preparer. Jacobsen never saw the return, which was filed before Lemmens's arrest. For 2011, Jacobsen himself provided the couple's tax information to the same preparer.

The IRS examined the returns after the embezzlement trial. For both years, the embezzlement income accounted for some of the adjustments. Representing himself before the Tax Court, Jacobsen requested relief for the taxes from the income from the embezzlement only and associated accuracy-related penalties for 2010 and 2011.

Issues: Sec. 6013(d)(3) provides that each spouse is jointly and severally liable for tax on a joint return.

A requesting spouse may be entitled to relief from joint and several liability under Sec. 6015 if certain conditions are met. A requesting spouse may be relieved of liability from an understatement of tax attributable to the other spouse under Sec. 6015(b). Under Sec. 6015(c), a requesting spouse may have his or her liability for a deficiency limited to the portion of the deficiency allocated to him or her. Sec. 6015(f) allows relief if it would be inequitable to hold the requesting spouse liable.

More specifically, Sec. 6015(b)(1) provides innocent spouse relief if all of the following conditions are met: (1) A joint return was filed for the year in issue; (2) the return contains an understatement attributable to an erroneous item of the nonrequesting spouse; (3) the requesting spouse establishes that in signing the return, he or she did not know and had no reason to know of the understatement; (4) it is inequitable to hold the requesting spouse liable for the deficiency attributable to the understatement; and (5) the requesting spouse's claim for relief is timely. Associated regulations and Rev. Proc. 2013-34 provide additional factors.

Jacobsen argued that he did not know about the embezzlement and he should be relieved of liability for the taxes attributable to the unreported income from it. The IRS argued that the relief should be denied.

Holding: The Tax Court held that these factors favored a finding that Jacobsen did not know or have reason to know of the omitted income in 2010:

His lack of financial education;

His lack of involvement in the family's financial affairs;

The absence of lavish or unusual expenditures;

That he was not likely to have detected the erroneous item because Lemmens embezzled by regularly inflating her paycheck, which was not obvious from the couple's bank account and would not have been separately listed on a tax return;

That he did not participate in the embezzlement; and

The embezzled funds had been consistently omitted also in prior years.

In addition, the Tax Court looked at the factors for equitable relief under Sec. 6015(f) and found that Jacobsen did not receive a significant benefit from the embezzled income. It also considered his lack of knowledge of the embezzlement, his compliance with federal tax obligations, and his disability and poor mental health. These, and the parties' divorce and Jacobsen's credible testimony, favored relief for the 2010 tax year. However, the court found that Jacobsen knew of the embezzlement at the time of Lemmens's arrest in June 2011, after the couple's 2010 return was filed but before their 2011 return was filed in April 2012. The court noted that while Lemmens provided the couple's tax information to their preparer for the 2010 return, Jacobsen did so for the 2011 return, when he did not inform the preparer of the embezzlement income.

The Tax Court held that Jacobsen was entitled to relief from joint and several liability attributable to the embezzlement income for 2010 under Sec. 6015(b) but was not entitled to relief for 2011 under either Sec. 6015(b) or (f).

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